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Sustainable Investing: The ESG fund that is attracting the most investor cash right now is hiding in plain sight

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The environmental, social and governance exchange-traded fund that’s seen the biggest inflows year-to-date isn’t a renewable energy ETF and doesn’t belong to one of the behemoth fund families.

The company behind the fund didn’t even put the term ESG fund, and two top research firms are divided whether it qualifies as an ESG fund under the governance pillar because of its theme.

That fund is the six-year-old WisdomTree Emerging Markets ex-State-Owned Enterprises Fund
XSOE,
-0.84%
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which invests in companies that are no more than 20% owned by a government and therefore is seen as a way to avoid the risk of government pressure on the company at the expense of outside shareholders. It had $4.77 billion in assets under management as of March 26. So far this year, it has gathered $1.2 billion alone, a 38% increase.

The next-biggest asset gatherer is a familiar name: iShares ESG Aware MSCI USA ETF
ESGU,
-0.22%
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the biggest ESG ETF by assets. It holds $15.2 billion – more than triple the size of the WisdomTree fund — and has seen 8% asset growth so far this year.

Two other iShares ESG ETFs has also seen significant flows so far in 2021: iShares ESG Aware MSCI EAFE ETF
ESGD,
-0.44%

and iShares ESG Aware MSCI EM ETF
ESGE,
-0.56%
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which have seen asset increase 21% and 13%, respectively. Vanguard’s ESG U.S. Stock ETF
ESGV,
-0.50%

rounds out the top five AUM growers, seeing 22% growth.

Todd Rosenbluth, director of ETF research at CFRA, says he was “caught off guard” by the strong growth in both the WisdomTree fund, and in a similar WisdomTree fund, WisdomTree China ex-State-Owned Enterprises Fund
CXSE,
-1.34%
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which has brought in nearly $1 billion in new funds so far this year.

“The ‘g’ pillar of ESG has been popular. Investors are more aware of China in particular, but also the heavy hand that government plays in certain industries in a non-shareholder friendly way,” he says.

The World Bank noted in a recent research report that performance problems with certain state-owned enterprises have been noted for decades.

Jeff Weniger, ​head of equity strategy, WisdomTree, says although the fund doesn’t have ESG in the name, it has been constructed to be an ESG fund through a few extra criteria such as screening out thermal coal and tobacco.

“We have some investors are doing a dedicated search for an ESG mandate, and others are just looking for high-quality emerging funds,” he says, adding that the emerging-market companies that are likely to be polluters are usually state-owned companies. 

He says the fund has been able to sidestep issues with Brazil and China, such as when Brazilian President Jair Bolsonaro fired the CEO of Petrobras
BRDT3,
+0.46%

PETRY,
-2.75%
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the state-owned oil company, and installed a military general with no oil and gas background.

“We were able to eliminate a lot of this headline risk, at least in the past tense, we would hypothesize that would be the case in the future sense,” he says. “The big one is always China.”

The three main Chinese ESG issues are the country’s oppressive treatment of the Uyghur population in the mainland, political pressure in Hong Kong and saber-rattling in Taiwan, he says.

Differing opinions

Elisabeth Kashner, director of ETF Research at FactSet, says FactSet classifies the WisdomTree fund as an ESG investment because of its corporate governance. FactSet’s view is that it is better to let private markets operate rather than to have state-owned companies, she says.

Because there are no set standards nor guidelines to define what is and isn’t ESG, research firms decide for themselves if a fund falls under the three ESG pillars.

Morningstar doesn’t consider the WisdomTree fund an ESG fund.

WisdomTree’s Weniger says 2021’s asset growth is almost all because of investor flows, as the fund’s performance is up about 3% this year. He notes interest in the fund started to pick up in August 2019 and continued into 2020. During that time the gains were a mix of flows and capital appreciation.

The fund ended 2020 up 28.6% for the year, about 11.5 percentage points above its peers in a diversified emerging markets category and about 10 percentage points above the MSCI Emerging Markets category, according to Morningstar data.

Rosenbluth suggests that part of the interest in the WisdomTree fund now may be performance-chasing. Some of the stronger-performing emerging market companies in 2020 were internet-related companies, such Alibaba Group Holding
BABA,
+2.02%

and Tencent Holdings
700,
-0.41%

TCEHY,
-2.83%
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the fund’s largest holdings. internet companies are a sector the state hasn’t invested in so far.

“For some people the governance is important. For others, they just want a performing ETF. And if you can show value being added, not just to make you feel good, then you’re more inclined to be viewed favorably by investors,” Rosenbluth says.

ESG fund flows mirror the larger market trend

Looking at the larger fund flows by equity segments may help explain the interest in the WisdomTree fund and other funds. FactSet’s research shows the four biggest equity segments seeing fund flows year-to-date are U.S. large cap, emerging markets (total market), global markets (total market) and U.S. total market.

That somewhat mirrors the flows into the iShares ESG Aware MSCI EAFE and iShares ESG Aware MSCI EM ETFs, both of which are total-market international funds, and the iShares Aware MSCI USA ETF and the Vanguard ESG U.S. Stock ETF, which are U.S. total-market funds.

The hefty flows into the top ESG funds show “that there really is heightened investor interest in ESG,” Kashner says.

While it’s impossible to say why the iShares products have seen such inflows, Kashner says even in the world of ESG, costs still matter. The fees charged by iShares are some of the lowest around for ESG funds.

“ESG investors are as price sensitive as investors in any other strategy. And while the price points may be a little bit higher than your plain-vanilla ETF, the fee war is pushing them all in the same direction. I think BlackRock has been pretty cognizant of how its products are priced,” she says.

Debbie Carlson is a MarketWatch columnist. She doesn’t own any of the funds or stocks mentioned in this article. Follow her on Twitter @DebbieCarlson1.

More from Debbie Carlson on MarketWatch

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BlackRock’s push on ESG and climate goals is coming at ‘a business-friendly pace’

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